Catalyst for higher stocks is no catalyst

Michael A. Gayed, CFA, winner of the 2014 Dow Award, is chief investment strategist and co-portfolio
manager at
Pension Partners, LLC., an
investment advisor which manages mutual funds and separate accounts according
to its ATAC (Accelerated Time and Capital) strategies focused on inflation
rotation. Prior to this role,
Gayed served as a portfolio manager for a large international investment group,
trading long/short investment ideas in an effort to capture excess returns. From
2004 to 2008, Gayed was a strategist at AmeriCap Advisers LLC, a registered
investment advisory firm that managed equity portfolios for large institutional
clients. In 2007, he launched his own long/short hedge fund,
using various trading strategies focused on taking advantage of stock market
anomalies. Follow him on Twitter @pensionpartners and YouTube
youtube.com/pensionpartners.

“Impatience translates itself into a desire to have something immediate done about it all, and, as is generally the case with impatience, resolves itself in the easiest way that lies ready to hand." -- Edward Sapir

Market volatility has certainly increased in the last few trading days on weaker jobs data in the U.S. and renewed fear over Europe and what happens following the weekend's elections in France and Greece. There is a lot of chatter that Greece may leave the euro after all, causing stocks to gyrate wildly with a pattern of deep losses at the open and a recovery in risk assets toward the close. I'm not convinced Greece leaving is a bad thing at all. If anything, it may serve as a relief for investors if the country can go back to the Drachma and devalue in an effort to stimulate growth.

I've brought up the idea recently in an article titled “The Bear Paradox and the negative narrative” that there is a real dilemma here for the bears. Given the strong inverse relationship of bond prices rising (yields falling) when stocks decline, a bet against stocks now means that you are also likely bullish on bonds given the interrelationship of the two asset classes. Yet, bond yields are at panic low levels already while stocks remain elevated.

If that flight to safety trade continues, then as stocks correct and decline, their dividend yields go up coinciding with bond yields (which are already at unattractive levels) dropping further. Meanwhile, companies like Intel (INTC) continue to raise dividends. This provides I think significant support for risk assets. I spoke about this at length on a recent CNBC interview with Louisa Bojesen in a segment which can be seen here.

The Spring Switch out of bonds and into stocks following the Summer Crash, Fall Melt-Up, and Winter Resolution hasn't been flipped yet, as my company's own ATAC (Accelerated Time And Capital) models have kept our clients largely in bonds following the first week of April. Money has continued to pile into the “bear trade” with global headwinds preventing the Spring Switch. What could be the catalyst for the “Great Re-Allocation” which I believe remains a high probability in the near-term? What is the reason money could chase risk out of risk-free?

Perhaps the catalyst is no catalyst at all.

Let's face it, the true Black Swan is not a 2008 repeat, but that reflation does persist and that stocks continue to rally. Given massive bearish sentiment toward stocks and the complete belief in the negative narrative, the fat tail may be a positive surprise. That positive Black Swan may simply express itself because of the length of time fear has lasted over a Lehman-like repeat.

In other words, the catalyst of a collapse resulting from a European “event” NOT playing out becomes the precise reason for why stocks can continue to rally, and the Spring Switch gets flipped.

The core thesis of the Spring Switch is that money will likely have to chase risk assets given that the risk of being in bonds is significant at these yield levels. Yields are this low specifically because of fear over an event, and not a slowdown in the economy.

I say this because the performance of 10-year Treasury yields is closely tracking the performance of the VIX index, which reacts to event risk getting priced in by investors. The price ratio below of the VIX relative to the iShares 7-10 Year Treasury Bond ETF (IEF) shows that. A rising ratio means the VIX is outperforming Treasuries. A flat one means the two are behaving the same. For a larger chart, visit here.

Notice that the ratio is around mid-January levels. Traders are behaving as if a bet on Treasuries is a bet on the VIX. A bet on the VIX is a bet on a “negative catalyst” and event which could cause a breakdown in stocks. Yet, the longer it takes for the event to materialize, the more impatient “insurance” buyers of risk in Treasuries and in put options will be. Meanwhile, low interest rates also lower the risk of a credit event.

In short, the positive catalyst is that the negative catalyst does not happen. And the longer it doesn't happen, the more likely the Great Re-Allocation into stocks takes place, as the positive Black Swan shows its feathers. Stock resilience remains for now. And while the Switch out of bonds and into stocks has admittedly not happened, the Spring ain't over yet.

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

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